Today morning when I was going for a walk, I saw a new tea shop on the corner of the road. To my curiosity, they were unconventionally clean-looking guys, maybe a new-age entrepreneur straight from IIT to disrupt the Tea chain business. There was a crowd and I waited for my turn, the kitchen looked like a chemistry lab with some barrels connected with other barrels to make tea.
On my turn, I orders my regular tea with ginger and opened my Gpay app, the IIT guy turned to me and asked me to pay 30 rupees. I was awestruck, WHAT– 30 rupeeess ???!!!
Have you ever thought of a roadside shop charging you a premium tea price, some 3-4 years back? Thanks to Covid, the virus changed the generation so quickly.
Coming to the matter!
We cannot stop the increasing price of the products that we use today. The price of tea, coffee, dosa, mobile, car, house, and school fees — all going to get higher price next year. And this enemy is called “Inflation”.
We live in India, where the inflation is not too-high, or too-low. We manage an average of 6-8% for the last 30 years. That means any product today is selling for Rs. 100 will become Rs.106-108 next year and, Rs. 112-116 next to next year. and so on.
I drink tea every day. Assume that I want to save my money to drink the same tea next year. The Rs. 30 that I have today cannot buy the same tea next year, because the price of the tea would have gone up by 6-8% next year. i.e. Rs. 30 would have become Rs. 32.
If I put my Rs. 30 rupees in a piggy bank at home. That is not going to buy me the same tea next year. In other words. My money in the piggy bank going to lose its value next year by Rs. 2.
If I have to buy the same tea for next year for Rs. 32. I have to plan how I make my Rs. 30 to earn Rs. 2 for a year so that It becomes 32 next year and buy me the same tea.
Interest Rate
Don’t you think it’s unfair that your money is losing its value? Yes!. And you ask this question to the government also, right? That is why they brought in a solution called “Fixed Deposits”.
The government keeps the Interest rates to compensate for the loss from Inflation. If you take the FD rates for the last 5 years, for example, it will exactly match the average inflation for that year.
| Year | Inflation Rate | FD Rates (General) | FD Rates (Senior Citizens) |
|---|---|---|---|
| 2018-19 | 4.55% | 7.25% | 7.75% |
| 2019-20 | 6.89% | 7.25% | 7.75% |
| 2020-21 | 4.29% | 4.5% | 5.0% |
| 2021-22 | 6.07% | 5.5% | 6.0% |
| 2022-23 | 6.00% | 6.3% | 6.8% |
You may see, sometimes the interest rates are far too high than Inflation. Please mind all the returns from FD are taxable. So after the tax, you will get less than Inflation rates.
So, there was an Inflation problem. And there is an FD solution. Right? The problem is solved. What’s next..?
Here is the Problem
The problem with FD is it can only compensate for the average loss of inflation. That means it keeps my value of Rs. 100 as Rs. 100 next year. That is I can buy my tea for 32 next year.
What if I want to buy a Car next year? The car will not have the same inflation as Tea, right? And what if I have to pay school fees for my girl next year?
The inflation for school fees runs in inflation of 10-12% for a year. That means if you have a child whose age is 5 years, by the time she enters college, the cost of her education almost triples.
I cannot save my money in FD for my girl’s education plan. If I do so, my money dies over a period of time and I cannot afford the same education that I planned today for her when she actually wants to join.
Likewise, all our consumption has different levels of inflation. Taking FD as a solution to all our goals is mere suicidal of money.
How education inflation can hurt your child’s future (moneycontrol.com)
Real Rate of Return
If you want to think one step further than just managing only inflation. What about “Creating Wealth”?
“Wealth is an accumulation of money that can make you rich to fulfill all your goals in life without compromising and have a surplus to leave for the next generation”. If you have to create wealth you have to generate a little higher rate of interest than Inflation. So that your purchasing power is sustained in the future and the value of money gets appreciated.
In simple terms we have to get a positive “Real Rate of Return” = The RRR.
If your inflation is 7% and you have invested your money in a product that can give you 15% then your (real rate of return) RRR is 15-7 = 8%. That creates wealth for you.
You ‘may not’ get the calculation convincing, let’s try the following method;
Let’s assume that you want to buy a car today which is costing Rs. 10 Lakhs. For some reason, you want to postpone this decision for the next 10 years. Now you got a problem, your 10 lakhs today cannot buy the car after 10 years because the price will grow at 7% every year. That means the price of the car will be 10 Lakhs x 7% x 10 Years = 20 Lakhs. The price of the car doubles in 10 years.
If you invest the same amount in FD, you can buy the car. But cannot create wealth, because the RRR is “0”. (7% Inflation – 7% FD rate = 0 RRR)
If you invest the same amount in a product that can give you 15%, then you get 40 lakhs at the end of 10 years. Now you can buy 2 cars after 10 years. The 10 years of time give you investment to manage the inflation and wealth to buy more.
If you invest the same amount in a product that can give you 15%, then you get 40 lakhs at the end of 10 years. Now you can buy 2 cars after 10 years. The 10 years of time gave your investment to manage the inflation and wealth to buy more.
What if the Inflation goes lower?
If the inflation goes lower than what it is now, let’s say 7% inflation goes down to 5%.
Then, you don’t have to worry because the RRR will be higher than earlier and can create more wealth for you. That means 15-5 = 10% RRR. Or a 13% return from investment will give the same result as 15% in the earlier case because the RRR will be 8% if the return is 13%.
Conclusion:
- Keep inflation in mind while making your investment decision.
- The goal in which you want to make an investment should at least deliver the inflation of that goal.
- If your returns are below the inflation, then your money is dying.
- Focus on RRR than the normal return
- Calculate Tax on returns and adjust in RRR while making a decision.
The Next Topic
What happens if the Inflation of a country rises abnormally like 20-30%?
